Tocqueville Asset Management2008 Year-End Investor Letter
January 2009
In this most tumultuous year for the financial markets, gold bullion rose 5.8%. In so doing, it
outperformed all asset classes and investment strategies other than unadulterated short selling.
Unfortunately, gold shares lost their traditional connection to the gold price and behaved like
stocks. The benchmark XAU index declined 27.7%, and small cap gold stocks did much worse.
The chart below depicting the relationship between gold shares and the bullion price shows that
gold shares became more undervalued relative to bullion than at any point in the past 25 years.
Even though the price of gold bullion rose in U.S. dollar terms, its performance was
disappointing in light of the dramatic collapse of high profile financial institutions; the rapidly
sinking global economy; the aggressive policy responses by world governments to rampant
deflation; and, the obvious disarray in public policy. Surely, in our view, this witches' brew of
misfortune should have driven the gold price well above $1000/oz.
Those of us who confess to disappointment in gold's performance failed to appreciate the power
of deflation and the implications of a complete breakdown in all mechanisms for the
transmission and distribution of credit. The final six months of 2008 demonstrated
unequivocally the dependency of incomes, including individual, corporate and government, on
credit in a highly leveraged economy. The hard lesson of this period was that credit = incomes =
asset prices.
Credit appears to hang on the slender thread of emergency life support supplied by gullible
taxpayers believing in the magic of regime change. As long as asset prices and incomes sink, it
seems most unlikely that profit oriented lending institutions will extend a penny of additional
credit to borrowers previously deemed creditworthy. The prescription of choice appears to be a
government cure likely to be worse than the disease. In this scenario, we find the only question
to be the date on which the rubber finally hits the road. When it does, dreaded deflation may
well be vanquished by epic inflation.
The investment world huddles today in the perceived safety of cash and treasury bills, accepting non-existent yields in hopes of further dollar appreciation and lower interest rates. In light of
record money creation and fiscal stimulus, what strategy could be more ill-advised? The
unstated objective of government economic stimulus would seem to be currency devaluation.
Success will be defined as inflation that alleviates debt burdens to a degree sufficient to rekindle
the appetite for risk in the private sector. Since nobody knows in advance how much inflation is
required, it is more than likely that policy makers will overshoot their objective. The results
could well be of Weimar proportions.
Gold bullion has held up its end of the bargain, preserving capital in the most adverse financial
climate in nearly a century. Moreover, it has risen for eight consecutive years against all paper
currencies. Now, world governments have embarked on a crusade to slay deflation via overt
currency debasement. It is difficult to think that gold bullion will suddenly turn into a
wallflower. In a January 5, 2009 Financial Times editorial, noted economist David Hale stated:
There is no country that wants its exchange rate to appreciate. The clear alternative to the dollar in
2009 is not other currencies but that ancient form of money: gold. Precious metals could emerge
as a hedge for investors suspicious of central banks and fearful that inflation will be the simplest
solution to the challenge of global deleveraging.
Gold shares have historically provided leverage to the gold price. 2008 was the exception that
can be explained by margin calls on equities of all descriptions. On several occasions last year
we stated that gold shares would come to life once the $1000/ounce threshold was no longer
regarded as a ceiling but as a floor. Shifts in macroeconomic thinking occur these days within
nanoseconds. In our view, this particular shift is likely to occur during the nanosecond
commonly known as 2009 AD.
Most investors seem willing to wait for clear evidence that the transition from deflation to
whatever lies ahead is complete. However, we believe that the rewards of anticipating what
seems likely to happen by making an allocation to the gold sector outweigh the clear risks of
sitting tight on a pile of cash and other supposedly "safe" assets. We look forward to much
improvement for gold and gold shares in 2009.
With best wishes,
John Hathaway
Portfolio Manager and Senior Managing Director
© Tocqueville Asset Management L.P.
www.tocqueville.com
January 9, 2009
This article reflects the views of the author as of the date or dates cited and may change at any
time. The information should not be construed as investment advice. No representation is made
concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast or
opinion will be realized.
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